Cut risk if home search near

These days, you don't necessarily need a 20 percent down payment to buy a home. But you will have to pony up some cash before you're handed the keys.

The median price of existing homes was $218,000 in November, the latest data available from the National Association of Realtors, so putting a mere 3 percent down could run more than $6,500, in addition to closing costs.

As you save for a down payment, one issue is balancing risk with return.

Generally, the higher an investment's return, the higher the risk and the chance you could lose money. And a down payment does not have as long a time horizon as your retirement savings to recover from market swings.

How do you save enough cash, and that means not dipping into your rainy-day fund, without taking on too much risk?

Depending on how soon you're ready to become a homeowner, consider these options:

A few months:

Spring is peak season for house hunting. If you're going to start shopping soon, you don't want to pick an investment that restricts access to your cash or carries any risk.

Your best bet is a bank money-market account, which you can draw on practically at will and is insured by the Federal Deposit Insurance Corp. up to $100,000.

Normally, the longer you commit your cash, the higher the interest rate, or yield, you earn.

But recently the yield curve, which plots the relationship between yield and an investment's maturity and normally slopes upward, has been relatively flat.

Nowadays, you can find money-market accounts paying as high as 5.4 percent, said Greg McBride, a senior financial analyst for Bankrate.com. Currently, the highest-yielding one-year CD pays 5.36 percent.

And by not locking up your cash, you don't risk having to pay a CD's early-withdrawal penalty, which can be as high as six months' worth of interest.

"The fact is there is such a narrow difference in yields between different maturities that the early-withdrawal penalty will more than set you back if you get the timing wrong," McBride said.

You can search for high-yielding money-market accounts at Bankrate.com. Also, check out yields on money-market funds, which are offered through mutual fund companies.

Money market funds are not FDIC-insured, but your principal won't lose value because the fund share price remains constant. And you can withdraw the money when you need it.

Rates are competitive: The current seven-day yield on the Vanguard Prime Money Market Fund is 5.09 percent.

One to two years:

Even if you don't plan to purchase a home for a year or more, it's still a short time horizon, said Deborah Feldman, president and director of financial planning at Leonetti & Associates in Buffalo Grove, Ill.

"You don't want to take any risk," she said.

The gamble is whether the Federal Reserve will raise short-term interest rates, now at 5.25 percent, or start cutting.

Bank accounts and money-market funds will closely track Fed moves. Feldman suggests keeping a portion of your down payment in either to benefit from a rate increase.

With the rest of your cash, she suggests splitting it between one-year and six-month CDs or Treasury bills, which will lock in higher yields if the Fed lowers interest rates.

Three to five years:

If you're still a few years from attending open houses, you could invest a slice of your savings in stocks and bonds.

"You have a little bit of a long-term window, but you have to remain cautious," said Brian Jones, a certified financial planner in Fairfax, Va.

He added, "The risk is it's March 2000, and the market is peaking."

Thus, putting all your cash into an equity index fund is not necessarily a smart idea. Instead, pick a balanced fund, which typically invests 60 percent in stocks and 40 percent in bonds.

Jones also recommends equity income funds, which hold blue-chip companies that pay dividends. In some cases, the funds also may hold bonds.